The 5G Dream Could Turn Into a Nightmare for Verizon.

Verizon Communications (VZ -1.74%) has been a leader in the wireless space for so long that many believe the company will retain its lead once 5G goes mainstream. Customers and investors alike are reminded constantly about Big Red's network dominance. While Verizon seems to be the leader in 4G, the 5G race is far from over. After years of premium pricing based on the best network, can the company compete effectively if it's not the 5G top dog? Verizon's stock hasn't exactly set the world on fire over the last few years. If the company loses its network lead, it could leave investors seeing red.

When best becomes a relative term

When cellphones were mainly for phone calls, the best voice network was of utmost importance. As more people move away from traditional phone calls to Marco Polo, FaceTime, games and more, voice coverage is still important, yet data speeds are nearly as critical.

Wireless network

(Source: Getty images )

According to WhistleOut , Verizon offers the best nationwide 4G coverage with users suggesting they get 4G coverage nearly 96% of the time. Verizon's CEO seems to agree, saying the company received  "confirmation from RootMetrics that our 4G network is clearly the best in the market." However, the Verizon lead has narrowed over the last few years and appears ready to narrow even further.

The same study suggested that AT&T (T -1.77%) gives its users reliable coverage about 93% of the time. In addition, the company's network provided the fastest download speeds of all the major carriers. In the past, T-Mobile (TMUS -0.02%) seemed stuck permanently in third place. However, the story changes when we combine Sprint and T-Mobile under one roof.

In the Opensignal study, T-Mobile was found to be only 0.50% less reliable than Verizon. However, the latter covers about 11% more territory. The difference between the Opensignal study and the future of these companies is tied heavily to 5G coverage. In fact, spectrum ownership is a big part of why the new T-Mobile was created. According to recent information , the combination of T-Mobile and Sprint, "owns more radio spectrum than AT&T or Verizon."

T-Mobile has been duking it out with Verizon and AT&T for years while consistently posting significant postpaid additions each quarter. According to a Tom's Guide study of wireless carriers, T-Mobile and Verizon were only separated by one point out of 100 when it comes to measures like network performance, plans, customer service, and more. Moving forward, the new T-Mobile has the opportunity to take that number one spot.

Verizon's pricing power problem

"The next generation of wireless technologies...promises blazing-fast data transmission speeds. ... Its higher data speeds could make smartphones much more comparable to PCs, giving them better multimedia and gaming capabilities." It might surprise you to know that these statements are from an article about 4G that is nearly ten years old.

In the last five years, Verizon has essentially owned the 4G market, yet the stock price's compound annual growth rate is a less-than-inspiring 3.3 %. It's true that the stock has offered a decent yield, yet T-Mobile's compound annual rate of return during this same time frame exceeds 20%. In short, while Verizon had the clear network advantage, T-Mobile's stock has been the superior investment. If we look at how Verizon prices compared to its peers, the company seems to rely on its network to create pricing power.

(Source: AT&T unlimited data plans – T-Mobile cellphone plans – Verizon unlimited plans)

It's not surprising that T-Mobile has been adding customers in droves given the pricing difference between the big three carriers. At $5 to $10 cheaper per month, per line, T-Mobile already seems like a better deal. When you add the iPhone 11 at a price $149 to $349 cheaper, customers are getting a much better deal. The company has been generating positive cash flow and significant growth in the current 4G race. The company's potential to lead 5G would seem to suggest T-Mobile can continue pushing the pricing barrier. Verizon's current pricing power may evaporate if T-Mobile takes the 5G lead.

Growth and income or better returns? The choice seems obvious

Given the significant disruption that COVID-19 has caused in the marketplace, it seems reasonable to compare financials from the end of 2019. We will use the new T-Mobile's calculated numbers from the separated T-Mobile and Sprint.

Let's get the obvious out of the way first: AT&T offers investors a yield of roughly 7%, and Verizon currently pays about 4.5%, while T-Mobile has no dividend. Looking at each company's financials, we get a sense of each company's strength and opportunities.

(Source: AT&T, T-Mobile, Sprint, Verizon end of 2019 quarterly earnings and financials – *T-Mobile figures are the combination of end of year financials and customer counts from T-Mobile  and Sprint  – Adjusted Free Cash Flow = net income + depreciation – capital expenditures)

Verizon is clearly the leader in revenue, service revenue, and free cash flow per $1 of revenue. AT&T has a larger wireless customer base, yet nearly 40% of the total comes from connected devices. The main thing that jumps out otherwise is the relatively low rate of free cash flow from the New T-Mobile. In addition, the New T-Mobile is only projecting free cash flow to "be in the range of $1.3 to $1.5 billion ." Of course, that isn't the full story as the company expects to achieve over $40 billion in synergies over the next several years.

In the end, the 5G dream that Verizon investors are having could turn into a nightmare. If T-Mobile can turn its superior spectrum ownership into superior 5G coverage, Verizon loses its most powerful pricing tool. AT&T carries a premium yield relative to Verizon and has a more diverse revenue stream. Between AT&T's better yield and T-Mobile's better growth potential, it's challenging to recommend acquiring Verizon at this time.